Educational Articles

Coverage Initiation: TransDigm Group (TDG)

Ian Gendler
| January 13, 2012

Value Line has initiated coverage of TransDigm Group (TDG). The company is a major designer and manufacturer of aircraft components. Its wide variety of products can be found on most commercial and military planes, with Boeing (BA – Free Boeing Stock Report) accounting for about 15% of the company’s total annual sales.

During the summer of 2003, in connection with several mergers, TransDigm Group was incorporated. In March 2006, it completed its initial public offering. At that time, 10.95 million shares were sold to the public at an average price of $21 per share. A secondary offering occurred in May 2007, when 10 million shares were sold at $35.25 per share. On both occasions, the underwriting syndicates included Credit Suisse (CS) and Lehman Brothers. The stock trades on the NYSE under the ticker TDG.

TransDigm designs and produces highly-engineered proprietary aircraft components. Its products include mechanical/electro-mechanical actuators and controls, ignition systems and engine technology, and specialized pumps and valves. It markets its offerings to aerospace/defense OEMs (original equipment manufacturers), distributors, commercial airlines, and the United States government and its allies. As mentioned, Boeing accounts for a large percentage of TransDigm sales, and its products can be found on nearly every aircraft that the Chicago-based aerospace behemoth assembles. Its products can also be found on most Airbus Industrie planes, as well (Airbus is a subsidiary of the European Aeronautic Defense and Space Company).

For TransDigm to continue to be successful, it must overcome competitive pressures. Its Industry is fragmented, with a number of companies offering similar components and services. That said, the aerospace/defense sector’s strict regulatory, certification, and technical requirements, along with the investments needed to develop products, creates material barriers to entry for potential new players. In addition, most aircraft programs remain in production and service for many years, sometimes decades, and the OEMs, due to the elevated costs and possibility of manufacturing delays, typically resist making supplier changes. Thus, TransDigm’s current relationships ought to be relatively secure, but it is vital that the company meet its delivery and quality expectations. Supplier contracts tend to be relatively long in length, which is another plus.

The health of the global economy is also a major factor. Typically, during times of economic growth, passenger air travel is at healthy levels, which provides carriers with the financial flexibility and incentive to upgrade and/or replace their aging fleets with new aircraft. Increased orders translate to greater production levels at Boeing, Airbus, and the other manufacturers of commercial aircraft. However, the opposite is also true. For example, during the 2007-2009 recession, a number of airlines went out of business, while others cut back their flight schedules and delayed or canceled new plane orders. During periods of poor economic conditions, TransDigm does stand the material risk of losing business, which would hurt the top and bottom lines.

TransDigm is also subject to shifts in defense spending by the United States government. Its OEM customers, like Lockheed Martin (LMT), Northrop Grumman (NOC) and Raytheon (RTN), among others, derive the bulk of their revenues from sales to the Pentagon. These large companies design and manufacture a wide array of products, ranging from software to fighter aircraft, and these offerings are used to protect the American people and the country’s interests at home and abroad. However, due to the immense cost, among other factors, of certain programs, it is common for military spending to come under fire from lawmakers, which can hamper orders and, in turn, reduce the need for some of TransDigm’s products. We suggest that shareholders, as well as interested investors, monitor the ongoing actions and comments of the White House and Congress in regard to military spending.

Although TransDigm possesses a number of long-term contracts which should lead to solid annual earnings gains, competition, economic conditions, changes in the Defense Budget, along with other outside factors, will dictate, to some extent, the level of success the company achieves. Subscribers are advised to monitor our regular quarterly coverage in The Value Line Investment Survey, while keeping an eye out for Supplementary Reports when breaking news takes place.

At the time of this article’s writing, the author did not have positions in any of the companies mentioned.